Is Delaware Changing the Way it Looks at Rule 12(b)(6) Challenges in Business Cases?

DENVER, CO. – May 1, 2019 – Is Delaware changing the way it looks at Rule 12(b)(6) challenges in business cases?

Recently, the Delaware Supreme Court has indicated a departure from years of Rule 12(b)(6) jurisprudence. Delaware Supreme Court Rule 8 prohibits parties from raising issues on appeal that were not “fairly presented to the trial court.”[1] In the context of Rule 12(b)(6) motions to dismiss, the traditional rule has been that a party “fairly presents” an issue to the trial court by alleging facts in the complaint that support a legally-recognized claim for relief. In deciding a motion to dismiss, the trial court and the appellate court accept the complaint’s well-pleaded allegations as true and draw all reasonable inferences therefrom in the plaintiff’s favor.[2] They seek to ascertain whether the complaint—under any reasonably conceivable set of circumstances inferable from the complaint’s alleged facts—states a valid claim under Delaware law.[3]

If the trial court grants a motion to dismiss, the plaintiff may appeal that ruling to the Delaware Supreme Court who conducts the same analysis de novo.[4] Traditionally, in conducting this de novo review, the Court focuses primarily, even solely, on the allegations in the complaint itself. As recently as February 2018, the Court reiterated, in an opinion authored by Justice Seitz, that in the Rule 12(b)(6) context, “Our review is limited to the well-pleaded allegations contained in the complaint, which we accept as true.”[5]

A case from September 2018, however, signals that plaintiffs can no longer rely on this “complaint-focused” approach, particularly in complicated business cases. In Miller v. HCP Trumpet Investments, LLC, the Delaware Supreme Court departed from the traditional path and dismissed the claim—on the basis of Rule 8—even though the plaintiffs’ complaint detailed the very arguments and issues that, according to the Court, were not “advanced” below.

Some factual and procedural context is helpful. The Miller plaintiffs were members of a Denver-based but Delaware-created business, Trumpet Investments, LLC (“Trumpet”). Trumpet was controlled by venture capitalists (collectively, the “HCP Members”). Trumpet’s operating agreement included a waiver of fiduciary duty claims but retained liability under the implied covenant of good faith and fair dealing.

The HCP Members used their control to force a sale of Trumpet to MTS Health Partners (“MTS”). The Miller plaintiffs filed suit in Delaware’s Court of Chancery. Through 95 detailed paragraphs covering 25 pages, the plaintiffs alleged that the HCP Members had breached the implied covenant of good faith in multiple ways, including:

  • Violating the plaintiffs’ reasonably-held expectations, at the time of contract, that the HCP Members would conduct a market check before selling Trumpet at a price well-below Trumpet’s market value, which below-market sale gave the HCP Members a 2x return but left the other members with little or nothing. (the “market-check argument”);
  • Holding the Trumpet board hostage by springing on them the below-market sale a week before the Christmas holiday and then giving board members five days to find competing offers (the “hostage-taking breach”);
  • Rejecting and attacking a much higher valuation contained in a legitimate indication of interest from a wealthy third party who wanted to buy Trumpet for much more than the HCP Members accepted from MTS (the “FFL breach”); and
  • Colluding with MTS to eliminate the FFL bid and intimidate Trumpet’s non-HCP-affiliated CEO (the “collusion breach”).

The HCP Members filed a motion to dismiss under Rule 12(b)(6).  In that motion, they attacked, primarily, the market check argument. Based on that initial attack, the market check argument dominated the rest of the briefing below, as well as the parties’ statements, and the Vice Chancellor’s questions, at oral argument.

The Vice-Chancellor granted the motion to dismiss and the plaintiffs appealed to the Delaware Supreme Court. As was the case below, the briefs, and oral argument before the Delaware Supreme Court focused primarily on the market check argument. Oral argument was held before the Court en banc. The panel’s questions and comments hinted that they were unpersuaded by the market check argument due to the contractual waiver of fiduciary duty claims. But questions from Justice Seitz and Chief Justice Strine also indicated that the other bases for breach of the implied covenant articulated in the complaint—the hostage-taking, FFL, and collusion arguments—supported an actionable claim. In fact, during oral argument, Justice Strine specifically referenced these other bases for breach and acknowledged that the Court was required to accept them as true under Rule 12(b)(6).  Therefore, under the Court’s well-established precedent for Rule 12(b)(6) claims, it would be expected that the implied covenant claims would be allowed to proceed under these independently-alleged bases for breach even if the market check argument was rejected.

But, surprisingly, the Delaware Supreme Court dismissed the implied covenant claim in its entirety. Analyzing why and how this happened informs how the Delaware Supreme Court is apparently changing the way it treats Rule 12(b)(6) motions. In a four-page order, authored by Justice Seitz, the Court rejected the breach based on the market check argument because, according to the Court, it sought Revlon-like remedies associated with the waived fiduciary duty claims. Given the panel’s statements at oral argument, this was not entirely unexpected. [6]

What is surprising is the Court’s rejection of the other independently-alleged bases for breach of the implied covenant—the hostage-taking, FFL, and collusion arguments.  Did the Court rule that these bases were not alleged in the complaint? No. In fact, the Court’s opinion acknowledged that they were so raised and that they potentially could support a claim for breach of the implied covenant. So, why did the Court reject the claim under Rule 12(b)(6)?  Because, according to the Court, the plaintiffs “did not attempt to advance” these “targeted claims” below and, instead, pursued their “key” market check argument.

So, what does the Miller case teach us about how the Delaware Supreme Court is reviewing motions to dismiss under Rule 12(b)(6)? Here are some observations and recommendations for plaintiffs seeking to defeat a motion to dismiss in Delaware:

  1. Do not rely on the Court’s review of the complaint. The Miller plaintiffs specifically, and independently, pled facts supporting breaches of the implied covenant based on the hostage-taking, FFL, and collusion arguments. If anyone questions this, pull the complaint and review, for example, ¶¶ 40-46, 53-77, and 91-93. Yet, the Delaware Supreme Court found that they failed to fairly advance these claims below, presumably under Supreme Court Rule 8.  One interpretation of the Miller result is that the Court now requires plaintiffs, in the Rule 12(b)(6) context, not only to allege independent bases for breach in the complaint, but to affirmatively advance each such basis for breach in the motion to dismiss briefing and at oral argument. The Miller plaintiffs relied, to their detriment, on the Court’s long-standing precedent that allegations in the complaint are the Court’s primary, and even sole, focus under Rule 12(b)(6) and that any such allegations supporting an actionable claim are allowed to proceed even if other, independently-alleged bases (like the market check argument) are rejected.
  2. Be careful what you emphasize, regardless of the complaint’s allegations. As would be expected, the Miller plaintiffs focused their motion to dismiss response brief on the specific arguments the HCP Members raised in their opening brief. The HCP Members focused primarily on the market check argument. They also addressed the other alleged bases for breach but did so more lightly. As a result, and as the process before the Court of Chancery and the Delaware Supreme Court continued, the market check issue dominated the briefs and oral argument, while the other bases for breach (those the Delaware Supreme Court found more persuasive)—though also addressed, were given less air time. One observation, therefore, is that the Delaware Supreme Court may use the tool of a blanket Rule 12(b)(6) dismissal to punish a litigant for emphasizing an alleged basis for breach with which the Court disagrees, even where the complaint contains other, independently-alleged breaches the Court supports. One way to avoid such a result, as a plaintiff, is to advance each and every theory of breach the complaint alleges, in every brief and at every oral argument before the trial and appellate courts. If Miller is any indication, failure to do so may be seen by the Delaware Supreme Court as an abandonment, even if those less-emphasized bases are clearly alleged in the complaint.
  3. Is Miller a case of judicial expediency? Casual observers may try to brush aside the strange Miller result, not as a shift in the Delaware Supreme Court’s treatment of Rule 12(b)(6) cases but, instead, as an example of an incomplete complaint and incomplete briefing. But such a view is not fair to the Miller Their complaint specifically articulated the “more targeted” claims of breach that Justice Seitz and Chief Justice Strine referenced during oral argument and in the dismissal order—the hostage-taking, FFL, and collusion arguments. Moreover, the “more targeted” claims, while not equally emphasized in briefing and at oral argument, were not left unaddressed in the briefs or at oral argument before the Court of Chancery. On the contrary, over three pages of the Court of Chancery’s opinion were dedicated to the treatment and rejection of these separately alleged arguments.[7] Nor were these arguments left unaddressed in the briefing before the Delaware Supreme Court. Even at oral argument, the Miller’s counsel, while conceding that the market check argument was emphasized below, confirmed that the other alleged bases for breach were addressed in the complaint and the briefing and presented to the Vice Chancellor for decision. Given these circumstances, is the Miller case simply one of judicial expediency? Did the Delaware Supreme Court—due to the divisive views about the implied covenant of good faith and fair dealing—perform a one-time departure from its well-settled precedent to rid itself of a case it did not want to address more fully?

So, where does the Miller case leave Rule 12(b)(6)? One alternative view is that the Delaware Supreme Court viewed the Miller case as an unattractive subject of a more in-depth opinion about the yet-unsettled and highly-divisive covenant of good faith and, so, manufactured a way to quickly dispense with it. Such a cynical result would be disappointing. The second alternative view is that the Miller case marked a shift in the way the Delaware Supreme Court treats Rule 12(b)(6) cases and serves as a warning to Delaware plaintiffs facing a Rule 12(b)(6) motion to dismiss: (i) not trust that a court will base its opinion solely on the complaint’s well-pled allegations; and (ii) if the complaint alleges independent grounds for breach of the implied covenant, to emphasize each of those grounds equally and in every brief and at every oral argument before both the trial and appellate courts.

[1] Del. Sup. Ct. R. 8.

[2]Clouser v. Doherty, Del. No. 57, 2017, Seitz, Jr. J. (Sept. 7, 2017) (2017 Del. LEXIS 363, *11) (citing Malpiede v. Townson, 780 A.2d 1075, 1082 (Del. 2001)).

[3] Winshall v. Viacom Int’l Inc., 76 A.3d 808, 813 n.12 (Del. 2013).

[4] Clouser, 2017 Del. LEXIS 363 at *11.

[5] Alston v. Admin. Office of the Courts, Del. No. 366, 2017, Seitz., Jr. J. (Feb. 23, 2018) (2018 Del. LEXIS 82)(emphasis added)(citing Ramunno v. Cawly, 705 A.2d 1029, 1034 (Del. 1998))

[6] Though not entirely unexpected, the question whether the implied covenant (a contractual duty), under appropriate factual circumstances, can require controlling parties to perform a reasonable market check before selling a company—even where fiduciary duties (a tort duty) are waived—is a compelling question that merits additional discussion despite the Miller opinion.

[7] Miller v. HCP & Co., No. 2017-0291-SG, 2018 Del. Ch. LEXIS 40, at **32-35 (Ch. Feb. 1, 2018).

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